Oftentimes, a client will come to talk to me and say “I want to put my assets into a trust.” My question of course is, What are you trying to accomplish? Who suggested it?What do you think a trust is?” Sometimes the answer is, “so my assets don’t get spent on a nursing home.” Often the client says,”I don’t want my assets to be spent on a nursing home, but can I still get money out of the trust if I need it?” The beauty of trusts is that there is so much variety and they can be tailored for each unique situation. So I thought I’d write a post explaining trusts in basic language. Keep in mind that trusts are governed by state law, and this is only a general overview.
A trust is an entity which has a fiduciary who manages the Trust’s assets for someone. It can come into existence and be funded during its creator’s lifetime, or it can spring into existence under the creator’s Will. It can be revocable or irrevocable. It can have one beneficiary or many beneficiaries. The creator may or may not retain control over the funds or access to the funds. The creator may or may not be a beneficiary on whom the funds can be spent.
To create a Trust, a document has to be prepared and signed. Sometimes “the document” is a Last Will and Testament (so the creator is called the Testator); other times “the document” is just a trust document (and the creator is called the Settlor or the Grantor). Since the Trust isn’t a human being, it needs a manager or handler, called the Trustee. The document must specify who the Trustee can spend the money on – that’s the Beneficiary. If the trust will be a separate taxpayer, it needs an EIN# or taxpayer identification number from the IRS. When it comes to the assets, I like to describe a Trust as a big empty box. Once it is written, signed, and has an assigned EIN#, it springs to life but is unfunded. The box is empty. The creator of the trust — or the estate of the deceased person who had written the trust into his Will — transfers assets into the trust; puts them in the box. Now the trust is funded and its life begins.
Who’s who? The Grantor, Settlor or Testator is the person who created the trust. The Trustee is the fiduciary, manager, handler of the trust’s assets, and is the person who makes the decisions concerning the assets. The trustee buys and sells real estate, stocks and bonds; rents out property, signs leases and collects rents; and follows the trust document’s instructions when making decisions about distributions.The Beneficiary is the person whom the Trustee can spend money for. Depending on what the document says, the Beneficiary may have some absolute rights to funds at certain times, or the beneficiary may have to depend on the fair exercise of discretion by the trustee. The Remaindermen are the people who will receive the trust money once the primary beneficiary dies.
Trusts can be revocable or irrevocable. A revocable trust can be cancelled/ revoked by the person who created it. An irrevocable trust cannot be changed or revoked after it is established.
Sometimes the person who created the trust (the Grantor) is the Beneficiary, and may even be the Trustee as well. This means that they have control over the funds and can spend the money in the trust on themselves. Usually these are called “Living Trusts” or “Revocable Living Trusts.” The funds in these trusts are typically considered available to the Beneficiary to the extent allowed by the document. So if the Grantor needs nursing home care or other health care, the funds in such a trust generally would be considered to be available to them to pay for care, unless the trust itself were specifically restricted.
Sometimes the Trust is restricted. For example. in an income-only trust, the Beneficiary receives all of the income but cannot receive any other distributions. Or the trust might say that the Beneficiary must be given 5% of the total trust every year, but no more than that. If the Settlor is not the beneficiary, then the funds s/he puts into the trust are no longer available to him/her and as a general rule would not be available to spend on care.
Someone has to pay income tax on the trust’s earnings, which are called the income. In some cases, the Trust files its own income tax return and pays the tax. in other cases, the Trust passes the income out to the beneficiaries and files a K-1, in which case the beneficiary reports the income on his/her own income tax returns.
The Trustee is the steward of the funds and has duties to each beneficiary and obligations to carry out the stated purposes of the trust. The trustee is not the owner of the funds, and there are prohibitions on self-dealing by a trustee.
Trusts have many purposes, and a trust that accomplishes one goal (such as “avoiding probate”) will not necessarily accomplish another goal (such as making an asset unavailable to the settlor’s creditors). A discretionary trust will likely not qualify as a special-needs trust. However, placing assets into a trust for one’s family members can have the effect of preserving the assets over a longer term, or keeping them out of the hands of young adults until they are older and more mature. Each situation calls for individualized planning.
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